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While the Singapore government has recognised the need to make changes to the Central Provident Fund system, which is as old as Singapore itself, the current situation is felt to be only a partial solution. Carl Redondo reports

Singapore's success has been built on economic policies that go back 40-50 years, and the relatively simple social security system - the CPF - has been part of the backbone of this success. The CPF was established to cover pension benefits, while also providing substantial medical coverage. It also allows employees to borrow against their account in younger ages to support housing costs.

The CPF is set up as a defined contribution (DC) system aimed at being the sole vehicle for pension and medical benefits - leaving employers free from the burden of running supplemental pension and medical plans. The contributions to CPF are split between employers and employees and are high when compared to the national pension systems of other developed countries.

The model worked relatively well from the time of its establishment in 1955, with both high- and low-paid employees relying on the CPF for most (if not all) of their retirement and medical benefits. This model of pure social security for key benefits is pretty much unique among other developed economies and is one of the selling points for companies setting up business in Singapore.

In recent years though, the CPF model has started to look a bit outdated. Increasing medical costs and improved life expectancy combined with ballooning property costs have meant that the CPF is suddenly looking insufficient for many employees. The government is unsure how to react to these demographic and environmental changes. It is clear that more money needs to be spent on pension and medical benefits but how do you do this without threatening the all important Singapore competitiveness?

Increasing the contributions to the CPF is the simplest reaction but employers already complain that the charges are high. Any increases may be perceived as additional tax on employers/employees and damage that low tax reputation.

The alternative approach would be to let employers and employees pick up the additional costs through supplemental benefits programs but this would destroy the CPF model that has made it so unique in modern economies.

The government's reactions in recent months have certainly not given any clear direction over future policy. On 1 January 2005 and 1 January 2006 (see table 1 for the details) the government cut the maximum salary that applies for CPF contributions, effectively reducing the CPF contributions for high earning employees.

These changes created a certain amount of angst among senior employees who began making noises about supplementary pension and medical benefits as compensation for these cuts to the CPF. Before companies could really take stock of the reduction in salary cap the government announced another change but in the opposite direction.

The CPF employer contribution rates were to be increased by 1.5% from 1 July 2007. See table two. The combination of these policy changes has been a re-distribution of CPF benefits (and costs) in favour of lower paid employees but probably more significantly; confusion as to the long term future of the CPF. Will the government continue to position the CPF as the only pension and medical vehicle or encourage (explicitly or implicitly) the development of supplemental benefits markets?

The government is already into its next review of the CPF with the outcomes to be announced in this year 2008. The results are eagerly awaited with all interested parties hoping for clarity over the future role of the CPF.

Many employers would prefer the supplementary benefits model rather than an increase in CPF contributions due to the flexibility it provides. A well structured supplemental plan allows companies the freedom to set costs and target benefits to key employees whereas control of the CPF costs and benefits rest with the government.

If the supplementary benefits model is to be pursued then it is likely that the government will build on a basic framework for a top-up pension plan that was introduced in 1993. The 1993 legislation introduced the concept of Section 5 pension plans which can be used as tax-efficient vehicles for supplementary benefits.

Section 5 plans have not really taken off with only a handful being set up in the 15 years since the framework was put in place. The legislation has also not been formally reviewed since 1993 and the structure looks outdated.

Under the current legislation, Section 5 plans must provide the same benefit formula to all employees, can only accept employer contributions and there are also only 60 unit trust funds that are available for Section 5 assets. The recent reductions in the CPF salary cap have meant that companies have been looking more closely at Section 5 plans but the restrictions associated with them mean that many companies do not see it as an appropriate solution.

The government indecision over the CPF and the inflexibility of Section 5 both show distinctly un-Singaporean characteristics.

Employers are expecting quick, decisive and business friendly solutions to this rumbling pension and medical benefits problem. For now, it's a case of watch this space but there is certainly expectation and pressure on the governmentto deliver.Carl Redondo is a senior international consultant with Hewitt in Hong Kong